Beyond the Hype
One of main questions that should come to mind for entrepreneurs at the end of the year is how to prepare for the future. Doing so, of course, means assessing the information in front of you. As is regularly touted in the media, the major U.S. economic indices are reaching uncharted territory almost daily, unemployment levels have dropped to just 6.1% and inflation is in check. These statistics are leading many people to believe that the economy has recovered. Yet, according to a national survey, 70% of Americans believe the U.S. economy is permanently damaged, while 84% do not believe the economy has improved since the recession ended in 2009.
So why the disparity? In reality, the U.S. economic outlook for 2015 is substantially different depending on your vantage point. Since the markets bottomed in March 2009, the S&P 500 has climbed approximately 200%, the NYSE is up 165%, the NASDAQ is up more than 260%, and the Dow Jones Industrial Average has gained more than 165%. The fact of the matter is that the U.S. is doing spectacularly well. Well, Wall Street is.
The Wealth Gap
If you're wealthy, 2015 will probably be another year of celebratory wealth creation. If, on the other hand, you're not wealthy, 2015 will feel an awful lot like 2014 and the years since 2009. Typically the media uses the stock market as the barometer for the country's economic health. Since the Federal Reserve enacted its quantitative easing strategy, the S&P 500 has soared to more than 200% in value, yet during the same time-frame, the number of Americans receiving food stamps has almost doubled to 46.23 million, or one-sixth of the American population. Wall Street and the U.S. government will tell you the economy is doing well, but as an entrepreneur you may not feel like it. In fact, you may find even encounter unexpected hurdles.
The Great Recession in the United States of America started in December 2007 and lasted for 18 months. In late 2008, in an effort to help kick-start the economy, the Federal Reserve under its Chairman Ben Bernanke initiated its generous bond buying program (quantitative easing) and sent short-term interest rates tumbling to near zero. The low interest rate environment was supposed to encourage banks to lend more money to businesses and people. However, this didn't happen exactly the way it was supposed to. Instead of making it easier to get money, America's big banks tightened their lending rules, taking the opportunity to strategically invest the money themselves.
Granted, the banks were more than willing to lend to well-heeled Americans. Since the Great Recession began, the top one percent of earners saw their incomes rise more than 30%, while the bottom 99% saw their earnings rise only 0.4%. During the so-called recovery, the top one percent captured 95% of the total growth in the U.S. The widening income gap has become so severe that it has contributed to Standard & Poor's (S&P) cutting its growth estimates for the economy to only 2.5% annually for the next decade-down from its forecast five years ago of 2.8%.
The stock markets may be doing well, but the underlying fundamentals that hold the U.S. Economy together are still struggling to recover. True, the jobless rate is down to 6.2% from nearly 10% four years ago, but other benchmarks tell the real story, including the number of people jobless for more than six months, the millions who are working part-time who used to enjoy full-time jobs, and stagnant wages. On top of that, the underemployment rate (U-6) remains at an eye-watering 12.6%. (Source: "The Employment Situation July 2014," Bureau of Labor Statistics web site, August 1, 2014.)
For those who do have jobs, their wages are lower than they were before the Great Recession. Wages for workers at every pay level, save for the bottom 10%, declined from the second half of 2013 through to the second half of 2014. For 70% of the workforce, inflation-adjusted hourly wages are still lower than they were in 2007. Over the same period, inflation rose 15%. So whereas employers have started hiring again, there remains a persistent high level of "personal weakness" among the work force: People are getting back to work, but they aren't doing as well as they used to do, and they know it.
Even U.S. housing, the "bright spot" in the U.S. economy, isn't as robust as many think. The Case-Shiller Home Price Index is up 25% since the beginning of 2012, but it still needs to climb an additional 20% just to break even with its pre-recession levels. Despite ultra-low interest rates, first-time home buyers are being priced out by all-cash purchases from wealthy foreign investments mostly from emerging markets like China, Brazil and Russia.
As a result, the number of first-time American home buyers getting onto the property ladder is lagging, accounting for just 28% of all purchases. The 30-year average, and a number that economists consider to be healthy, is 40%. The National Association of Realtors also notes that nearly half of Americans said that their student loan debt is an obstacle to buying a home. First-time home-buyers are an important part of the U.S. Economy, and if they don't buy homes, they can't pay for upgrades, renovations, new appliances, furniture or other goods and services. If they aren't buying, construction companies aren't building or employing as many people either.
And that adds up. Historically, residential investment (construction, remodeling, etc.) has averaged around five percent of U.S. GDP. Housing services, which includes gross rent, utility payments, and imputed rent (an estimate of how much it would cost to rent owner-occupied units), averages between 12% and 13%-for a combined total of 17% to 18%.
A Global Perspective
Economic factors outside the U.S. will also have a serious impact on the U.S. economy in 2015. Russia, one of the world's biggest economies, is on the brink of a recession as a result of sanctions related to ongoing conflict in Ukraine. Russia's economic ministry halved its 2015 GDP forecast from two percent to one percent.
This past summer, while most New Yorkers were out in the Hamptons having a blast with our BBQs and friendly gatherings, it was reported that Italy, the third-largest economy in the eurozone, had fallen back into recession.
Germany, the region's largest economy, is grinding down and France, the second-biggest economy in the eurozone, is also in a precarious position. In the second quarter of 2014, Germany reported a decline in its GDP-this represents the first decline since the first quarter of 2013. In August, the ZEW Indicator of Economic Sentiment (a survey on the health of the German economy) posted a massive decline, collapsing 18.5 points to a lowly 8.6 points. Having been declining for more than half a year, the index is now at its lowest level since 2012. This does not bode well as we head into 2015, unless you have the entrepreneurial notion, that is.
France, the second-biggest economy in the eurozone, is in a worse spot economically - and a recession may just be around the corner. In 2013, France's GDP rang in at just 0.4%. During the first half of 2014, France's GDP came in at zero!. In addition to a stagnant economy, France faces record unemployment and a growing deficit. On top of that, Prime Minister Manuel Valls warned the autumn months would continue to be difficult. It doesn't look like 2015 will be a prosperous year for the eurozone, especially when you consider its three biggest economies are in jeopardy.
Why should we, as Americans, be worried about the eurozone economy? Approximately 40% of the public companies that make up the S&P 500 derive sales from Europe. If the Eurozone faces a sustained economic slowdown, the corporate earnings of American companies will suffer. America won't be able to skirt the consequences of an economic slowdown in the eurozone if the U.S. economy itself remains weak. After all, it's been the lethargic U.S. economy that has necessitated near-zero interest rates for six years. With that in mind, it's difficult to imagine the U.S. could weather a global economic slowdown unscathed.
That doesn't mean the stock market won't continue to do well; it all depends on when the Federal Reserve decides to start increasing interest rates. Initially, the Federal Reserve said it wouldn't raise interest rates until the U.S. economy was on sustainable economic footing. Many take that to mean a jobless rate of 6.5% and inflation of 2.5%. The unemployment rate is already below the 6.5% target and U.S. inflation is near 1.5%. It's quite possible that the U.S. economy will hit those targets in early 2015 and the Fed will choose not to raise interest rates because it believes there is too much uncertainty. The Federal Reserve will announce on March 18, 2015 whether or not it will raise interest rates from zero.
If the Federal Reserve decides the economy is on the right path and raises interest rates sooner than expected, it's quite possible the stock market will go through a short-term correction. An increase of 50 basis points could shock the system and negatively impact the broader economy-making it more difficult for people and businesses to borrow and lend. If this were to happen, investors might want to consider banking stocks and growth stocks, and new start-ups investments with excellent well-calculated exit strategies.
Over the remainder of the year, the Federal Reserve would monitor how the economy is doing and decide whether or not to move interest rates higher…or lower. Maintaining the current ultra-low levels would signal there is still work to be done and that rates will probably not rise until later in 2015-possibly October. If this happens, investors will, in all probability, remain bullish, sending the stock markets higher over the coming seven months. Waiting to announce an interest rate hike until October 2015 would allow the U.S. economy more time to set itself on a more stable, sustainable course. It would also allow the U.S. economy time to better understand or assess where the global economy is heading. Because an interest rate hike in October 2015 would be expected, it would come as less of a shock. As a result, the major U.S. stock indices would be prepared to absorb the expected hike.
What kind of companies thrive on higher interest rates? Few are looking forward to interest rate hikes more than banks. America's big banks want interest rates to climb. When interest rates do start to increase, lending institutions will raise the amount they charge for the loans faster than what they pay on deposits. For America's big banks, these higher rates will translate into higher profits.
Investors to the Rescue
Don't be alarmed. Despite the obvious economic warning signs, investors are not yet ready to throw in the towel. Entrepreneurs like you and me are the answer to how we can improve the economy. Investors continue to be increasingly optimistic toward a stock market that many believe is both overvalued and ripe for a correction. But it appears as though investors don't care if the markets are overvalued so long as it keeps going up. While bearish indicators continue to surface on a regular basis, there's no reason to think the markets are going to correct in the near term.
To appease shareholders, companies are going to continue to "financially engineer" their earnings. Cost-cutting measures and using cash to repurchase shares and increase dividend payouts is known to be a short-term strategy for boosting earnings and supporting high stock prices, yet investors seem content with this strategy. Eventually though, companies will need to report sustainable revenue growth. That's going to be difficult for a country that relies on consumer spending to drive roughly 70% of its GDP to run at full steam when the vast majority of the population is struggling. Caution will define the mind-set of the consumer in 2015, and many traditional ways of dong business will have to be redesigned, replaced, or abandoned to get them to spend. Opportunity exists for innovative new companies that can provide products, services and business models capable of thriving in the challenging, yet optimistic economic environment that we can expect in 2015.